Viking
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"Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us
believe it is insane to risk what you have and need in order to obtain what you don’t need."
Add to leverage, aversion to high concentration, and this is a lesson from 2013-2014 that I am not about to forget.
When things go your way for years (almost 2 decades), delivering 10-20%+ above index returns (pre-leverage) and appear easy, you are highly subject to make over-confidence mistakes and to ignore some risks.
I also wish I had never heard of Buffett's bet that he could make 50% returns with a small sum. Setting high goals is essential in my opinion to achieve something great however, when ambition becomes too large it too makes you ignore some risks.
Cardboard
Cardboard, solid advice I need to pay more attention to...
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Like Trump or not like Trump it is clear the US today has a much more business friendly government. Taxes have been reduced greatly. Regulation is being stripped away. Optimism of business people in the US is at historic highs.
Trump also is implementing a US first trade stance. NAFTA is currently being renegotiated and it is reasonable to assume Canada will be a net loser with any changes made.
Oil and gas has been one of the engines that a has powered the Canadian economy the past 15 years; not anymore.
Housing has been THE engine of growth powering the Canadian economy the past 8 years but with Canadian household debt to GDP at historic and world highs and interest rates heading higher it is hard to see this continuing.
Politically, federally and provincially (I live in BC) we have governments that are spending inherited surpluses to pay off base (who voted them in), raising taxes on businesses and adding more regulation (pipeline in BC is a great example). Moving forward businesses that can set up in Canada or the US will increasingly pick the US. This will take a couple of years to play out.
When I weave it all together I see lots of risks for Canada moving forward. As a result 90% of my investable assets are in US$ and will likely stay there for the near term.
One possible repreive for Canada is if commodity prices spike higher as usually happens late in an economic cycle (as forecast by Gundlach and others). If this happens our stock market will likely outperform other world markets given its concentration in resource stocks. It is possible we also just muddle through (nothing terrible or good either).
I am an optimist generally but am finding it difficult when looking at Canada’s medium term economic prospects.
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Results came out on the 15th.
On the 16th, Crip and I both pointed out that there often seems to be a time lag between the time the results come out and share price movement.
Share price has barely moved until today and now pops 4-5%. This happens quite frequently and is almost like having advance knowledge of the results.
+1
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I was very happy when FFH purchased ORH in 2009. Prem telegraphed the purchase in advance and I think there was a lengthy discussion on this board speculating that a buyout was possible/likely. I think a number of investors made a lot of money. Could the final price have been higher? Sure. Was the final price for ORH at the time fair? My view was yes. Investors in ORH also had the opportunity to roll their money into FFH shares.
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Is the culture at Fairfax such that they are able to keep their key people long term? I am very impressed with Brian Bradstreet, Andy Bernard and more. Zenith is a great example of How FFH likes to do acquisitions and the fianancial results at this company post acquisition have been stellar. Looks to me that very smart people at FFH believe in the company; if they did not they would simply leave. There is lots to like about Fairfax and I do believe much of that is due to the culture they have built over many years.
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Here are my remaining notes from the conference call. Please correct any errors as you see fit :-)
US tax reform:
- took a $326 million charge in Q4 (reduced value of DTA)
- it sounds like US tax reform will be a solid benefit for FFH.
- During the conference call FFH said 60% of their business is in the US but did not provide an estimate for the new expected tax rate.
- RBC today lowered their effective tax rate estimate for FFH for 2018 from 26% to 19%; this is a significant reduction.
Interest rates:
- As short term interest rates move up FFH should see nice growth in interest income given they have about half of the investment portfolio in cash and short term investments.
- Prem said FFH has not reached for yield with its investment portfolio while other insurers have
- feels higher inflation is likely; interest rates could increase significantly and credit spreads could widen
Investment income
- Prem talked up recent C-span warrant deal: builds investment income by $15 million per year. With possible capital gains kicker
- similar to Corus, AGP? and Altius
- like these deals
Insurance rate renewals
- generally, rates are no longer going down; rates are flat to increasing (varies)
- casualty 0-5% increases;
- property 10% increases; loss affected areas seeing increases of 20-25%
$2.4 billion cash at hold co
- NOT looking for acquisitions
- looking to buy back stock
- Prem said during the Q&A it is highly unlikely dividend will increase
- Prem also said they would like to take Eurolife, Brit and Allied 100% private (no timeline given); this did not sound imminent to me but why mention it if it was not on the table for 2018?
Allied World:
- $50 million Q4 reserve increase was related to one specific claim (casualty)
- FFH continues to think they are very well reserved
- cat losses were higher than FFH expected; cat losses in the future will be less (FFH does this different than Alied World and Allied World will change to FFH practice)
FFH India
- FFH performance fee is paid in shares (as per agreement); ownership has increased from 30 to 33%.
- if FFH India trades at 2X book value, FFH can take performance fee in cash
- Bangalore airport designed for 20 million passengers; currently serves 25 million; under expansion to serve 65 million over next 3-4 years
- FFH India building lots of intrinsic value for shareholders
Gravilia & Eurobond Investments
- as Greece economy moves up continues to improve their investments should do very well
- Prem mentioned Ireland as a comparable... when the Irish economy turned for the better their investments there jumped in value significantly
Tail macro risks (does not expect any of these to play out)
- risks: China, world trade disruption, recession
- deflation hedge at $40 million on books; will keep position and hold as insurance for worst case scenario
Refinancing their high interest debt (due over next couple of years) at much lower rates available today. Looks to be a very smart thing to do if you are expecting interest rates to move higher. Hits earnings in the short term but positions the company very well for the long term (if I understand the mechanics properly)
- At the end of December the company completed an early redemption of its remaining C$388.4 million 7.5% unsecured notes due August 19, 2019 for cash consideration of C$430.6 million recognizing a loss of $26 million which is included in “other expenses.”
- On December 4, the company issued C$650 million principal amount of 4.25% unsecured senior notes due December 2027.
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Just finished listening to the conference call. Here are some thoughts:
Prem’s summary at the end of the conference call:
- currently have a run rate of $15 billion in net written premiums
- have underwriting discipline
- portfolio of $40 billion; will build investment income
- HWIC playing offense
- all grounded on fair and friendly culture built over 32 years
- we expect we will generate 15% return for our shareholders for 2018. This means around $2 billion in net income or $70/share
The RBC analysts during the Q&A session asked if Prem was issuing guidance with his statements above. Prem said of course not; FFH does not provide guidance. The RBC guy said that someone listing to the call who was not familiar with Prem might take his comments for guidance.
I am surprised that Prem would be so bold to make such a specific comment if he did not have a concrete plan to hit it. Otherwise it just looks like he is trying to talk the stock price up.
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The key moving forward, as it usually is with FFH, is how they invest. What is the plan with the $17 billion in cash and short term investments? Given the results posted over the past 5 years I think many people are in wait and see mode.
As bond yields move higher the decision in Q4 2016 and Q1 2017 to sell long dated bonds and move to cash has certainly been a good one. But it may take 12-24 months before FFH starts making meaningful purchases of long dated bonds again. Patience will be important.
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From the press release: “At December 31, 2017, common shareholders' equity was $12,475.6 million, or $449.55 per basic share, compared to $8,484.6 million, or $367.40 per basic share, at December 31, 2016. Common shareholders’ equity at December 31, 2017 does not include the unrecorded pre-tax $1,233.1 million excess of fair value over the carrying value of investments in associates and certain consolidated non-insurance subsidiaries.”
Allied World Q4 combined ratio = 132; looks like they bore the brunt of $185 million in catastrophe losses due to California wildfires. I hope this business is getting some nice price increases and turns things around in 2018.
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CNBC had an 8 minute interview with Nancy Davis of Quadratic.
At about the 4:30 minute mark she discussed how QE and rising bond yields are disrupting the volatility trade.
My key takeaway is the impacts are not over and they are going to be significant and nobody understands how it will play out. Very interesting discussion (most of the other panelists simply said nothing as it was clear the discussion was over their head).
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Mr Pink, this may not be the answer you are looking for. My filter on investing ethically is to focus on management. Are they trustworthy? Are they straightforward in their communication with shareholders? Do they deliver on promises? If not, why? If they are not trustworthy, I will sell my shares (if I hold any) and move on. As in have said before, it normally takes me three conference calls to get a handle on management.
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Value Maven, thank you for posting and sharing that you have been a long term shareholder of Allied. What are your thoughts of the size of the underwriting loss posted by Allied in Q3? I am just starting to follow Fairfax closely (after many years) and one of my watchouts is the size of the lost posted by Allied and Brit in Q3. I am not saying it is an issue; at this point I am just trying to learn more.
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Cardboard, thank you for getting the discussion going on this.
Here was my experience. Back in Dec when the US Federal Government said it was not supportive of legalizing pot (or something like that) there was a panic with pot stocks in Canada. The surge in trading that resulted caused RBC’s trading platform (used by those with self directed accounts) to fail. For much of the day it was not possible to log in to your account execute a trade.
When the online trading account is not working, you are to call in to execute your trade. The problem is the phone lines were swamped and the wait times to get through were +4 hours.
For high net worth customers (for RBC Royal Circle that is customers with more than $250,000 in assets), RBC has a separate phone number that is supposed to provide quicker service. This line also had wait times of +4 hours. The message simply said something to the effect, “we are experiencing higher than normal call volume and we will get to your as soon as we can”. It did not communicate a rough wait time.
So basically investors were unable to trade online or contact anyone to execute a trade for much of the trading day. The system did get back up and running late in the trading day. All of this was caused by a spike in volume of pot stocks.
I was not impacted personally by what happened that day as I do not own any of the pot stocks. I was lucky. However, it did alert me to some serious issues that I needed to problem solve.
1.) what do I do the next time their online system crashes? At some point we are going to get a real sell off in the market. If something as small as pot stocks can cause the system to crash, what happens when a real sell off happens and trading volume spikes, likely on multiple days?
2.) what do I do when the phone lines get overwhelmed?
3.) when 1 and 2 above fail what can I do to execute a trade?
I called RBC a week later and was told there is nothing I can do. I simply have to wait until their either fix their online system or a phone line is freed up. And the answer is the same if you are a high net worth individual. I asked if it was not possible to go into one of the bank branches and be able to execute a trade there and the answer was a definite no.
I told them that this was a very important issue to me and if they were not able to provide a solution I may need to move all of my investments. The person said they record all calls and she would review my call at their weekly meeting. I have received no call back.
I called BMO recently and reviewed the situation with them. They had the same issues as RBC I was told. Their online system crashed. And their phone lines had wait times of multiple hours. And, just like RBC, they have no solution when the same thing happens again in the future (as I am sure it will).
Just like when investing, I try and be forward looking when managing things that are important. The time to fix something is not when you are desperate. Solving this issue is going to take a little more digging :-)
Does anyone out there have a solution they are happy with?
PS: I told both RBC and BMO that if a company can find a solution to this issue they will be well positioned to pick up lots of new business (as surely I cannot be the only investor who feels it is a very important issue).
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Bond yields spike and stocks... do nothing. WOW. Volatility looks like it is coming back.
Sept 27 2016. Jan 1 2018. Jan 31 2018. Feb 1 2018
US 2 Year. 0.75 1.92. 2.14. 2.16
US 10 Year. 1.56 2.46 2.72. 2.78
US 30 Year 2.28. 2.81. 2.95. 3.01
Gundlach said 3% was the critical level for the 30 year; he said once the 30 year passed 3% you can officially put a pitchfork in the bond bull market and call its end. We will see how fast yields continue ie to move higher. Currently the experts are calling for the 10 year to hit 3% by the end of the year... looks to me like 3% will be taken out by the end of March.
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Long bond yields are continuing higher. The question is not if yields continue to move higher; I think higher yields is understood and accepted by financial markets. The question is rather how fast they will rise and at what level will the stock market start to pay attention.
What is the real driver of higher yields? I do not think fears of inflation is the driver. Rather, I think there is finally a realization that central banks around the world are currently far too accomodative with policy. The economies in the US, Europe and Japan have reached a stage where central banks need to normalize policy. And financial markets and economies appear to be ok with higher rates. The Fed gets it and is normalizing policy quickly. I think the ECB is just starting to get it.
I am sure something very significant is happening in the bond market; just not sure how it all plays out. In late December of 2018 when we look back on the year I think this may be the surprise story of the year. The move in yields the past 16 months has been pretty dramatic. We will see what the next 11 months have in store. Very interesting :-)
Sept 27 2016. Jan 1 2018. Jan 31 2018
US 2 Year. 0.75 1.92. 2.14
US 10 Year. 1.56 2.46 2.72
US 30 Year 2.28. 2.81. 2.95
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Dazel, I think we are still in the early days of the Fairfax turnaround. Long bond yields have just started their next leg higher and yields could continue to move higher for the next couple of years. Yes, FFH has positioned its bond portfolio very well and the company is sitting on a bunch of cash. However, my guess is FFH will not be rewarded by Mr. Market simply for playing good defence. FFH has dramatically underperformed for the last 7 years; it is going to take time (my guess is a couple of years) to rebuild investor trust.
Investors are going to want to see how the cash is deployed and this will likely happen slowly over the next couple of years. Investors will reward FFH for driving earnings and growing book value, just like any other company. This will be hard to do in the short term when 1/2 of their portfolio is sitting in cash and short term investments ($17 billion of $35 billion).
I agree that FFH is positioned very well. The shares are cheap (and I am a buyer once again for the first time in many years). If the long bond continues higher and FFH shares continue to go lower I will be happy to buy more shares.
I am looking forward to FFH releasing Q4 results. Lots to learn:
1.) How is bond portfolio positioned compared to Q3?
2.) How much cash is at holding company level?
3.) What will they be doing with $1 billion after tax proceeds from First Capital sale? If used for share repurchases then, yes, we could see a jump in the share price.
4.) What is the plan with $17 billion cash and short term investments?
5.) Updates on loss estimates from this past year; any new news? How does reserving a Allied look?
6.) How is insurance pricing for 2018 looking? What kind of price increases are they able to get?
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The restaurant business is very challenging. I am happy FFH is selling The Keg. There must be much better opportunities out there to redeploy the cash.
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I find currency is probably the area where I have the weakest understanding/sophistication. As a general rule I try not to make it too big a factor in my investment decision. I think the country you live in is a factor; I live in Canada and tend to invest mostly in the US.
Watching TV and listening to all the ‘experts’ what I hear is many are waiting for the ECB to get more aggressive with slowing its purchases of bonds and to eventually actually start to raise rates so in the coming years 10 year bond yields in Europe will move much closer to those in the US; so the expectation of this will result in a higher Euro over time. It sounds like the currency markets are forward looking; the rates you see today reflect what people expect to happen down the road.
If you look at current 10 year bond yields in Germany and the US you would expect money to be flowing to the US for the much higher yield and for the US currency to be appreciating (please correct me if my logic is wrong). This is not happening.
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Moving forward, I think the ECB and BOJ will be key to long bond yields.
It really has surprised me what the FED has been able to accomplish in the US in the past 15 months. The Fed has demonstrated over the past 15 months that a central bank can raise rates from crazy low levels with little impact on the overall economy; they just need the guts to do it :-). I think back to pre-Sept 2016 and for 8 years straight all everyone was talking about all day was what the Fed was going to do. Today they are way down on the list of topics (and still important).
The ECB and BOJ have to tighten at some point in time so when the next recession comes they have options. They have a window today to do so. IF they do start to shift their stance I think bonds on the long end could spike (with a quick move of 40 or 50 basis points) and this could certainly spook stock markets.
I think the number one risk to the stock market today is a rapid rise in 10 and 30 year bonds. But this will only happen if the ECB and BOJ shift and get much more aggressive with slowing bond purchases and hiking rates; may happen in 2H if global economies continue to show solid growth.
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Over the years I have read many times that if you want to understand what is going on in the economy you should pay attention to what is going on in the bond market (more so than the stock market).
The yield on the US 10 year bond is now trading at 2.66%. Gundlach, in his last conference call said the key level, from a technical perspective, was 2.63%. He said if this level was breached, one could call an official end to the bull market we have seen in the 10 year bond for the past 30 years. Gundlach also said once 2.63 is breached 3.00% is the next level to watch and rates will likely move up towards this level over 2018.
Gundlach also called for the S&P to finish the year down in 2018 (which is quite the gutsy call given everything that has happened the past 14 months): after a strong start, as the 10 year moves close to 3.00% he expects stocks to sell off later in the year as higher bond yields (and the threat of even higher bond yields in 2019) eventually starts to factor into stock market valuations.
Buffett has said many times that he does not feel the stock market is expensive when the US 10 year treasury was yielding In the low 2% range. I wonder what he will say when the 10 years is yielding 3 or 3.5%?
If bond long yields continue to move higher my base forecast is we are going to get a lot more volatility in the stock market. If the 30 year bond bull market is indeed dead then we are entering a new world for investors. Might be good to raise some cash if stocks continue their parabolic ascent. Sounds to me like the bond bell is starting to ring :-)
PS: Fairfax looks to be positioned pretty well if 10 year yields move a lot higher :-)
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Companies who were paying high taxes in the US are immediate big winners; shareholders are also big winners. Yes, some of the windfall may be competed away over time; we will see. In the longer term, this also makes the US much more competitive. All of Trump’s trade rhetoric will also have an effect over time (motivates executives to grow in the US).
If you are a company looking to expand your business the US is becoming a much more desireable country to do business. Lower taxes. Less regulation. Great optics with current administration.
Countries like Canada and Mexico are clear losers. The political risk right now is quite high. What would motivate an executive to build any new factories in Canada or Mexico since the Trump election with all the uncertainty over what the trade agreement will look like between the 3 countries. If your choice of country is close of course you will pick the US.
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I have also learned over the years to stay away from industries that are shrinking or facing disruption (newspapers being a great example). This is not to say that money cannot be made, it is just much more difficult.
One of the keys to investing success is to invest in sectors and companies that have lots of positive tailwinds. As time goes by surprises tend to be positive and this drives the share price higher. Time is your friend. In struggling industries, the surprises tend to be negative and this results in lower share prices. Time becomes the enemy of a patient investor.
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Petec, no offense taken. Two people can look at the same situation and come to two very different conclusions; does not mean one is right and one is wrong. It often comes back to what ones objectives are and investing style.
Dalzel/cigarbutt, regarding the large amount of cash at the holding company, yes, it will be interesting to see what FFH does. Prem has clearly stated that he feels the shares are cheap and buybacks are likely. I wonder if they will wait and see if there is a bit of a hard market as we start 2018 and therefore an opportunity to grow the business organically. I think he has stated another large acquisition is not likely. I would like to see them start to get the share count down. You can see all the shares that have been added the past 10 years on the one page summary at the beginn8ng of the annual report. If I had to guess i think they will end up using the excess cash to reduce the share count; if this happens we should see a nice jump in the shares. This is another reason I bought shares recently (I got concerned they would not stay cheap). Shares also go ex dividend Jan 17 and this will net shareholders US$10 per share a week later.
BRK Book Value Feb 2018?
in Berkshire Hathaway
Posted
longinvestor, great estimate of BV :-)
Actual number = $211,750